Financial Markets Regulation - BIS requirements

This is a substrad of key points and technical notes of the regulation framework for measure and quantitative applications in Financial Markets. This is in the context that Capital Accord requires capital charges to cover market risks (of losses in on- and off- balance sheet positions) in addition to cover credit risks.

Technical as JPMorgan describe for RiskMetrics:

"Banks' minimum capital charges will be calculated as the sum of credit risk requirements under the 1988 Capital Accord, excluding debt and equity securities in the trading book and all positions in commodities, but including the credit counterparty risk on all OTC derivatives, and capital charges for market risks. The proposal sets forth guidelines for the measurement of market risks and the calculation of a capital charge for market risks."

 Measurement of market risk

 The market risk is measure using bank's internal models or the standard approach.

 

In the context of market risk the banks models have to be approved by the supervisory authority.  

Capital charge for market risk

 

Measuring Market Risks - Methods

The capital ratio 

Measure bank's financial stability. The base formula 

[CapitalRatio = (BankCapital / riskWeithedAssets)*100]

Technical notes for aplication:

• The minimum capital ratio is 8%.
• Denominator of the ratio: credit risk weighted assets + (measure of market risk*12.5)
•  Numerator is elegible capital: TIER 1, Tier 2 or Tier 3 as permited.
• Basell III reference to Common Equity Tier 1 (CET1) Ratio 
• [CET1Ratio = commonEquityTier1Capital / riskWeithedAssets]
•  It is report in intervals (commoly quartely) but Banks are expected to manage market risk in a continuous basis.
  

Backtesting

 Backtesting gauge the quality and accuracy of banks’ risk measurement systems: [compare where the observed percentage of outcomes covered by the risk measure is consistent with a 99% level of confidence]. Represents the comparison of daily profits and losses with model-generated risk mea-
sures.

Technical notes:

• The Committee framework calculate the number of times that the trading outcomes are not covered by the risk measures using the most recent 12 month of data.
• The boundary are based on a sample of 250 observations.

 Range  of posible response are classsified into tree zones:

 

 

 

Concepts:

Issuer risk: is the risk associated with the financial health of the entity issuing the financial instrument. If the issuer, whether a company or a government, faces financial difficulties, it may be unable to meet the promised payments. 

Consult reference:

 J.P.Morgan/Reuters. (1996). RiskMetrics - Technical document. New York.